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Microfinance Investments: What are the Impediments to the Integration of Social performance in Investment Decisions?

Ludovic Urgeghe

Working paper : 2012/1 Centre de Recherche Warocqu

Microfinance Investments: What are the Impediments to the Integration of Social performance in Investment Decisions?

Ludovic Urgeghe1 Teaching and Research Assistant, Center for European Research in Microfinance, Warocqu Business School, Universit de Mons, Belgium.

Mail address : 20 Place du Parc, 7000 Mons, Hainaut, Belgium. Phone : +32(0)65373277 Fax : +32(0)65373054

Email : Website:

The author would like to thank the Association of the Luxembourg Fund Industry for funding and supporting this research, in particular Tomas Seale, Jean-Luc Neyens, and Laetitia Hamon. The author would also like to thank LuxFlag for their help in contacting the participants to the study.

Microfinance Investments: What are the Impediments to the Integration of Social performance in Investment Decisions?

Abstract The Microfinance Investment Vehicles industry is today at a bottleneck. In a context of a damaged reputation due to recent crises, the whole field of microfinance and especially the investment vehicles, funded by public money and by socially inclined investors, have to demonstrate and justify their commitment to social returns. We use a conceptual framework of impediments to SRI (Juravle and Lewis, 2008) to identify the main impediments to the integration of social performance as a decision criterion for microfinance investments, by analyzing qualitative interviews of 9 microfinance fund managers. To the best of our knowledge, this is the first study to apply this framework to microfinance. The overall finding is that while social performance is recognized by respondents to be an important topic for the industry, fund managers still dont give a strong role to social criteria in investment decisions. We argue that this is linked to a number of major impediments such as the tendency to believe that microfinance is social per se, the lack of standardization in social performance tools and also a loose regulation regarding social reporting.

Introduction The last decade, microfinance, the provision of financial services to the poor, has experienced a shift called commercialization. It started when Microfinance Institutions (MFIs) adopted some commercial practices, for instance the periodic publication of balance sheet and profit and loss statement. Then NGOs began transforming into regulated commercial institutions, and some traditional commercial banks started to enter the microfinance sector. The last stage of commercialization, according to Halpern (2000) would start when microfinance would attract a significant number of private investors in search of a competitive return on investment. This stage is now reached. Most mature MFIs have direct or indirect access to international capital markets to get financed and the microfinance funding industry has grown tremendously fast over the last five years. The recent and noticeable development of specialized investment funds (called Microfinance Investment Vehicles MIVs) is a striking example. Mostly funded by donors money and socially motivated investors, these relatively new actors claim to contribute to the social mission of microfinance institutions and this objective translates into the search of the double bottom line, meaning getting financial and social returns from investments. This specific feature tends to characterize MIVs as belonging to the Socially Responsible Investments (SRI) category. Indeed, SRI is an investment 2

process that integrates social, environmental and ethical considerations into investment decision making (Renneboog et al., 2008, p.1). In the SRI sector, the utility of investors is not exclusively linked to the maximization of the risk/return ratio, but they also care for their personal and societal values when making investment decisions. Under that banner, MIVs have been gathering many investors willing to create a social impact with their money. Since the early days, MIVs have been able to grow by investing in best-inclass MFIs, which provided the best profiles in terms of risk and return, without feeling the need to justify explicitly the social side of the investment. As a result, it is not totally clear how MIVs are positioned within the broader sphere of SRI regarding the type of approach they use and the way they integrate social criteria into their investment decisions. For instance, is their screening based on exclusion criteria or on the actual measure of social performance? Moreover, recent developments in the microfinance industry such as overindebtedness issues and suicide waves in Andhra Pradesh (India) have damaged the sectors reputation, and investors (and the public opinion in general) are now pushing MIVs to be more transparent on their commitment towards social performance. In this context, this paper aims at putting forward the debate on MIVs ability to effectively contribute to the social mission of microfinance by investigating the impediments to the use of an SRI approach by MIVs. Our approach is twofold: first the SRI literature is reviewed in order to draw some insights on the role of social performance and its measure by SRI funds; and the second part is based on the analysis of 9 semi-structured interviews of microfinance fund managers in order to understand the current state of social performance as a decision criterion in microfinance investments. Our overall finding is that while social performance is recognized to be an important topic for the industry, there is still no clear role for social criteria in investment decisions. We argue that this is linked to some major impediments such as the tendency to believe than microfinance is social per se, the lack of standardization in social tools and also a loose regulation regarding social reporting. Our contribution is structured in four sections. Section 1 presents MIVs and the challenges regarding the specificities of social performance in microfinance. Section 2 presents a targeted review of the SRI literature on the investment approaches, their potential impact on corporate behavior and performance, and a presentation of the main impediments to the development of SRI that have been identified so far. Section 3 presents a qualitative study that identifies the impediments to the use of social performance criteria for investments in microfinance, using 3

the framework of SRI impediments presented in section 2. Section 4 draws some insights that microfinance can learn from SRI and concludes.

1. Microfinance Investment Vehicles and the double bottom line Currently 104 MIVs, for the most based in Western Europe, are financing MFIs around the world. Based on a study by MicroRate, for 2009, 81,6% of the investments were made through loans, 17,6% through equity, 0,5% through guarantees and 0,3% through other types of tools (MicroRate, 2010). This international funding plays an essential role by fuelling the growth of microfinance institutions, and according to some observers, only international capital markets can handle the estimated volume of $200 billion needed to reach the potential demand for microfinance services worldwide (Swanson, 2008; Daley-Harris, 2009). MIVs are investment structures that channel worldwide investments to microfinance institutions, either coming from public, individual and institutional investors2. Their structures and legal forms have evolved in time3, and are now very heterogeneous regarding their commercial orientations and business models. Nevertheless, the vast majority of MIVs claims to have a double bottom line objective, meaning getting simultaneously a social and a financial return on investment. MIVs have developed a lot in a small amount of time, thanks to a great interest in microfinance from investors. Their number went from 43 in 2004 to 104 in 2008, and their assets under management have grown six-wise to reach US$6.5 billion as of December 2008 (Reille et al., 2009), and recent estimations increase that number to 8.4 billion for 2009, with an estimated growth rate of 29% (Reille et al., 2009). The MIV market is highly concentrated, the assets value of the five biggest actors4 represents 53% of total investments of the sector
The global distribution of MIVs funding sources in 2008 was: 42% institutional investors, 34% individuals, 21% Development Finance Institutions, and 3% from other MIVs (Reille et al., 2009b).
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The first study about MIVs presented three categories of actors, following the balance between financial and social objectives and the types of investors targeted: development funds, quasi-commercial funds and commercial funds (Goodman, 2003). CGAP (Consultative Group to Assist the Poor) recently updated this typology and MIVs are now sorted in six categories (Reille et Forster, 2008).

Based on asset value as of December 2009, the five biggest MIVs are: (CGAP, 2010): European Fund for Southeast Europe (EUR 836 mio), Oikocredit (EUR 770 mio), Dexia Microcredit Fund (EUR 541,7 mio), ResponsAbility Global Microfinance Fund (EUR 489.4 mio), et SNS Institutional Microfinance Fund I (EUR 261.2 mio).

and geographically, 76% of investments are focused on Eastern Europe and Latin America (Reille et al., 2009). Since the early days, MIVs have been gathering many investors willing to create a social impact with their money. They have been able to grow by investing in best-in-class MFIs, which provided the best profiles in terms of risk and return, without feeling the need to justify explicitly the social side of the investment (De Schrevel et al., 2009). However, the situation has changed. First, there is today a mismatch between the number of MIVs and the number of MFIs capable of absorbing their funds. Observers of the ALFI (Association of the Luxembourg Fund Industry) conference in March 2010 concluded that the current MIV market might have reached saturation, raising serious concerns about the industrys future development. Nobody knows the exact figure5, but observers estimate that only a few hundred MFIs qualify to receive funding from the 104 active MIVs, with respects to their investment criteria. Currently targeted MFIs are mostly first-tier MFIs: the most mature, profitable and professional of the sector6. Although at the beginning these institutions were naturally the first choice of MIV to promote microfinance investments, placement opportunities in these institutions are gradually shrinking as new MIVs are set up and go on focusing on the same market niche (De Schrevel et al., 2009). Hence, the long term sustainability of MIVs is questioned, although they accept to take some additional risks by approaching less developed and profitable MFIs, but which could provide a sufficient social performance. In order to pursue such a strategy, MIVs will therefore need to justify better the social performance of their investments to their back investors. Second, the reputation of microfinance as a socially responsible investment has been quite damaged recently. The recent global financial crisis has had an impact on the microfinance industrys perceived risks by the outside world; concerns are especially growing about its ability to ensure a social orientation in difficult times (CGAP, Citigroup, CSFI, 2010). In addition, recent suicide waves due to clients over-indebtedness in India face microfinance
A recent study showed that for 2009, the top 7 MIVs were financing 574 MFIs, among which 85.35% from tier one (Wiesner and Quien, 2010). In order to better account for the microfinance sectors heterogeneity, MFIs have been classified into different sub- populations according to their level of professional maturity and profitability (Dieckmann, 2007). Hence, first-tier MFIs (profitable, often regulated, most known of the sector) are often opposed to second- and third-tier MFIs, which are still under the minimum profitability requirements and are often non regulated institutions (a lot of NGOs belong to that category).
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with serious image deterioration. The whole microfinance sector should now prepare to defend and justify its social mission. Regarding the available tools for measuring social performance, there have been many initiatives in recent years to make the concept of social performance evolve: we started with very few quantitative and standardized indicators such as percentage of women clients, total number of borrowers and average loan size (SEEP Network, 2008); but these indicators have shown their limits: although inexpensive and easy to obtain, they dont take either contextual differences into account, nor the fact that social performance is a multidimensional and mostly qualitative concept, much closer to what mainstream literature calls Corporate Social Responsibility (Urgeghe, 2010, Lapenu, 2008 and 2003). As a consequence, the Social Performance Task Force7 has recently defined social performance as: "The effective translation of an institution's social mission into practice in line with accepted social values such as serving larger numbers of poor and excluded people; improving the quality and appropriateness of financial services; creating benefits for clients; and improving social responsibility of an MFI." ( With this new definition, the challenge is even bigger for MIVs who want to demonstrate their commitment to social performance.

2. Socially Responsible Investments: methods, impacts and impediments The concept of Socially Responsible Investments (SRI) is closely linked to the one of Corporate Social Responsibility (CSR). Indeed, the idea behind CSR is that beyond their economic objective, firms also have ethical obligations and must respond adequately to pressures from society (Sethi, 1975; Carroll, 1979). Although limited to corporate philanthropy at the beginning (Cochran, 2007) the concept of CSR then evolved into the idea that real social responsibility was not just giving away money to some charities, but investing in projects yielding social and economic benefits (Porter and Kramer, 2002). Socially responsible investments are deeply rooted in corporate social responsibility (CSR) principles, as they appeared to respond to some undesirable corporate behavior, with the objective to
Together with CERISE (and their development of the SPI Social Performance Indicators) at the European level, the SPTF is a global initiative led by practitioners to set a common standard for social performance measures in microfinance.

have a positive impact on society by investing in socially acceptable firms and sanctioning undesirable behaviors, while also aiming at a financial return. Indeed, SRI is an investment process that integrates social, environmental and ethical considerations into investment decision making (Renneboog el al., 2008) that aims at least at two objectives: providing socially motivated investors with the right investment choices, and changing the behavior of firms through the application of CSR policies (Schepers and Sethi, 2003).

2.1 SRI methods There are two main investment approaches in SRI: negative screening and positive screening8 (Renneboog et al., 2008; Steurer et al., 2008; Juravle and Lewis, 2008; Bollen, 2007). Negative screening means that investments are excluded according to specific criteria, for instance firms involved in alcohol or tobacco. After having applied the desired filters, portfolios are created through a financial and quantitative selection. Positive screening is an approach where investments are selected because they meet higher CSR performance; this approach thus requires to actually measure CSR. SRI funds can also apply a combination of negative and positive screening (Renneboog et al., 2008) and finally, SRI funds can use the engagement strategy (Steurer et al., 2008, ORourke, 2003). With this strategy, also called shareholder activism, investors use their voting rights as shareholders to have an influence on firm governance in order to support good behavior or sanction undesirable management actions. In practice, SRI funds rely on a large extent to available information of companies social performance to make their decisions. Such information can be gathered in-house by SRI funds analysts, but most frequently investors rely on independent rating agencies to compile relevant CSR information on firms (Steurer et al., 2008). As major players of CSR assessment, rating agencies act as main providers of information for SRI investors. The main objectives of CSR rating institutions are to (Schfer, 2005 in Steurer et al., 2008, p.10):

Steurer et al. (2008) actually distinguish eight SRI strategies: negative screening, ethical exclusions, positive screening, best-in-class, norms-based screening, pioneer screening, engagement, and integration. Nevertheless, all eight strategies are considered as variations of the positive and the negative approaches.

Collect information from companies, analyze (screen) and monitor them; Identify potential business risks; Expose potential social and environmental value with respect to shareholder value; Act as a communicating intermediary between companies and their stakeholders (in particular investors interested in SRI); Serve as a guide for companies and consumers when it comes to CSR; Identify and promote best practices with respect to CSR management; Influence the behaviour of companies participating in the capital markets in favour of increasing their CSR; Promote SRI in all respects (positive and negative screening, shareholder engagement and advocacy). We observe that CSR rating agencies play a much broader role than the sole assessment of companies, and are deeply involved in the double mission of SRI: comply with investors societal values and influence corporate conduct. CSR ratings are used every day by SRI funds to make their investment choices, but they can several drawbacks: the lack of standardization in their methodologies and their screening criteria, and also the subjectivity in their assessments because of often incomplete information (Van den Bossche et al., 2010; Chatterji et Toffel, 2010 ; Steurer et al, 2008; Schfer, 2005). In addition, most rating agencies aggregate CSR information into quantitative indices to give scores to companies. According to Van den Bossche et al. (2010), these indices give a feeling of accuracy to the evaluator but dont capture the real essence of CSR. Indeed, the main characteristic of the SRI process is that the underlying phenomenon that is measured, CSR, is complex and multidimensional.

2.2 SRI impacts Regardless of the existing flaws in CSR information and processing of it, the literature suggests that the objectives of SRI - appropriate screening and influence on firms behavior can be achieved in practice. First, the SRI field has demonstrated a significant behavioral impact on firms, influencing subsequent CSR performance when firms obtain a specialized rating. For instance, studies from the environmental performance perspective (Chatterji and Toffel, 2010; Barnea et al., 8

2005) find that SRI investors can induce polluting firms to reform by under-investing, and that firm with poor environmental performance tend to react positively (by increasing their CSR performance) after receiving a bad CSR rating. ORourke (2003) argues that CSR assessment of firms has positive and negative effects on their behavior. On the positive side, when answering to a particular CSR assessment (very often a questionnaire), a company is required to represent itself on the terms that the fund criteria have set, meaning that SRI criteria act as a reflexive tool for companies: they become able to judge by themselves how their own performance is positioned towards industry standards, and also how this performance is communicated to their stakeholders. This process also improves the quantity and quality of CSR information produced by firms. On the negative side, ORourke argues that the multiplication of different approaches for CSR assessment by SRI funds or rating agencies results in conflicting messages about information requirements that may confuse or irritate company officials responsible to responding to such requests (ORourke, 2003, p.690). Second, the relationship between financial and social performance has been extensively investigated in the SRI literature, and most mainstream studies observed a positive correlation between a companys social performance and its financial performance. For instance, Margolis and Walsh (2003) reviewed 127 studies investigating the SP-FP link, and Orlitzky et al. (2003) did the same with 52 studies from 1972 to 1997, reaching the same conclusions. To sum up, even if the lack of standardization in CSR assessment methods is a problem, SRI have a rather positive impact on corporate behavior and moreover, social performance has been proven to be positively correlated with financial performance of companies invested by SRI investors. However, the mainstream investment community is far from adopting SRI practices on a large scale, and the next section provides some explanation of this situation.

2.3 Impediments to SRI Integrating CSR principles in investment decisions is not an easy objective, and there are many obstacles in the investment value chain that impede the SRI process to function as it should. Indeed, although there is a large amount of thought around SRI, these practices are not adopted by most institutional investors. Juravle and Lewis (2008) have helped conceptualize and organize the elements that impede the adoption of SRI practices by 9

mainstream investors. Based on an extensive review of the academic and practitioner literature, the authors present the impediments to a true SRI behavior in three levels of analysis: individual, organizational and institutional. We hereafter summarize the main elements to be considered in each level9: Individual impediments are primary found in the behavioral finance literature, and consist in the many common human flaws that investors display as individuals: overconfidence causing excessive transactions, heuristic simplification and emotion-based judgments (e.g. having positive illusions regarding the consequences of our actions), and over- or undervaluation caused by extrapolation of recent performance (Daniel et al, 2002; Shiller, 2000; in Juravle and Lewis, 2008). Also, risk and uncertainty aversion are very often found in financial markets and lead to too much focus on financial performance. Organizational impediments relate to the complexity and variety of investment funds organizational structures (private/public, mutual funds, insurance companies, banks,) which can differ in terms of size, time horizon, active or passive management, location of fund management, and professional legitimacy. For example, internally managed funds show a higher preference for social performance than those managed externally, and this is mostly due to the way fund managers compensation and incentive schemes are designed, according to Brammer et al. (2003). Organizational culture, with its underlying beliefs, can be another impediment to the integration of social performance in the core investment process. Institutional impediments concern the cultural and institutional systems of which organizations are a part (Hoffman, 2001, p.134) and we can distinguish three types of pressuring mechanisms that organizations face: coercive (e.g. regulation, duties of prudence leading to a focus on return maximization), normative (e.g. professional standards, need for legitimacy) and mimetic processes (e.g. the herd behavior, well-known in financial markets featuring high risk and uncertainty). Based on this framework, we draw a parallel between the Socially Responsible Investments world and the microfinance investments industry. Indeed, the MIV industry shows many similarities with the broader SRI sector, but is still in its adolescence and could benefit from the lessons learnt so far in the SRI world. As our main research question is to understand the

See appendix 1 for the conceptual framework of Juravle and Lewis (2008).


challenges and the difficulties for MIVs to increase their commitment to social performance, we find particularly relevant to apply the Juravle and Lewis (2008) approach in microfinance in order to identify the impediments to true SRI behavior by MIVs. To the best of our knowledge, our study is the first one to adapt this framework to microfinance investments. Moreover, the Juravle and Lewis (2008) paper focuses on the European market, where most MIVs are incorporated, and on institutional investors, which represent the biggest part of MIVs funding today (see Section 1).

3. What are the impediments to social performance in microfinance investments? Insights from Microfinance fund managers Section 2 has shown the advantages of SRI methods for screening and impact on corporate behavior, and the impediments to the development of SRI. We now make the bridge with MIVs through a qualitative study, in order to learn the best possible from the SRI experience regarding the application of social performance as an investment criterion. We conducted a qualitative study based on 9 semi-structured interviews of microfinance fund managers, applying the Juravle and Lewis (2008) framework to microfinance10. By applying this framework to microfinance funds managers, the objective is twofold: understanding how they perceive and use social performance criteria in their decision-making; and identifying the main impediments to the use of social criteria for investments.

3.1 Data collection and Methodology The qualitative study, aiming at exploring the perceptions and practices of MIVs regarding social performance, was based on telephone interviews with microfinance fund managers. SRI theory states that fund managers are key players in the investment value chain, as they are very often left with the final investment decision (Juravle and Lewis, 2008). In collaboration with ALFI (Association of the Luxembourg Fund Industry), a list of contacts of MIV fund managers was obtained. We screened MIVs within this contact list to construct
Some of the items of the framework have not been covered by the questionnaire because of their irrelevance with the microfinance case or the impossibility the assess them based on the interviews (e.g. Valuation models, Returns relative to index).


the most diverse sample possible, following the CGAP MIV peer groups (see CGAP 2010 MIV Survey, p. 37 for the peer groups). The list of respondents is available in appendix 2. 25 microfinance fund managers were initially contacted and after several emails, reminders and direct phone calls, 9 finally accepted to take part to the study. The study has been conducted in two steps, between December 2010 and March 2011. First, a preliminary questionnaire containing eight questions has been sent to the selected fund managers. The purpose of this first set of questions was twofold: first to understand the specific mission of the MIV, its observable social focus and second, to identify its relative weight within the MIV industry in terms of assets under management, geographical distribution and also the type of investors targeted. As a second step, we conducted a phone interview (18 questions, mostly open, around 45 minutes) with each respondent. The selected approach was a semi-structured interview, based on an interview guide designed according to the Juravle and Lewis (2008) framework. Here are some examples of questions and their corresponding item(s) in the Juravle and Lewis (2008) framework:
Question asked - examples Do you think microfinance is a social investment per nature? Why? Is microfinance a risky market for investments? Why? Is social performance taken into account for the final investment decision? What weight do you give to social aspects? How is performance of fund managers determined? Is social performance taken into account? Do you think there is a trade-off between financial and social performance in microfinance? What is the main reason for that? Are you subject to specific rules in terms of fiduciary duty to your investors? Can you explain? Are your investors satisfied with the information provided in the reporting? Type of Impediment Individual Item Positive illusions


Risk and uncertainty aversion Lack of ESG integration, Ethics/ business split



Performance review, remuneration and career management Dominant values: financial returns, Positive illusions

Organizational, Individual


Regulatory pressures Duties of prudence


Accountability deficits Demand for SRI


Regarding the number of respondents, samples in qualitative studies are generally much smaller than those used in quantitative studies. Indeed, qualitative studies are concerned with meaning rather than generalization of findings, and as Mason (2010, p.1) states, there is a point of diminishing return to a qualitative sample - as the study goes on more data does not necessarily lead to more information. According to the saturation principle (Glaser and Strauss, 1967), the data collection process should stop when new data collected does not bring any further insight on the topic under investigation. We observed this phenomenon quite clearly during our interviews. Besides, the information received with the preliminary questionnaire allowed us to compare the average respondent with the whole MIV industry and in total, our sample accounts for 26% of industry assets, and shows very similar characteristics in terms of assets under management, financial instruments, geographical coverage and types of investors represented (see appendix 3). Interviews were transcribed using notes taking and/or tape recording. We used thematic analysis as a systematic procedure: thematic analysis is a procedure that focuses on identifiable themes and patterns of behavior that come out of qualitative data (Aronson, 1994). Indeed, the particularity of this study is the application of an existing framework, which was the basis for the questionnaire. We had already defined a number of categories (individual, organizational, institutional impediments and their sub-categories), and following the thematic approach, we placed all relevant pieces of data into the corresponding categories. That way, themes that emerge from the informants stories are pieced together to form a comprehensive picture of their collective experience (Aronson, 1994, p.1). In the next section, we present the findings, consisting in a summary of fund managers perceptions and opinions regarding the three levels of impediments to SRI.

3.2 Main findings 3.2.1 Individual impediments Firstly, we assessed the perception that fund managers have of microfinance as an investment field, asking if they see microfinance as a social investment per se or not. While all fund managers acknowledge the limits of microfinance as a poverty reduction tool by itself, most of them see microfinance as social by nature. 13

Yes, microfinance is social per nature because of its mission: its about financial inclusion of poor and excluded people. Social aspects are predominant, namely helping people organize their activity to generate income. Yes, this field is social per nature. It is not a normal field; the logic is not purely commercial. For instance, the high interest rates and the funding conditions are exceptional; you wouldnt have this in a normal field. Indeed, the poverty alleviating objective is predominant in respondents discourse; only two answered that microfinance is not social per nature, and that the social side lies in the good policies and business set up of MFIs. Based on the summary of all answers, we detect most fund managers display positive illusions about microfinance, hence their tendency to simplify the complex reality and to talk only about the noble goals of microfinance without enough stress on the risks that it involves if not done properly (e.g. over-indebtedness). We argue that this too positive perception is a major impediment to a formal integration of social performance in investment processes, because it supports the idea that all MFIs are social, even those with good financial performance only. We also find that even though all respondents declare being concerned with social performance they provide very different definitions of it, some citing the old quantitative indicators only, some being aligned with the latest definition of the Social Performance Task Force, some are mixing social performance with the notion of impact, some others talk about client satisfaction only In a broad way, it is about having a positive effect on society, on community, and protecting the environment Is the social mission/vision put into practice? Are there results on clients? Focusing on assets increase is also a good social performance measure. SP is mainly about the average loan size, the number of borrowers reached, the gender and where do the clients live its giving access to different types of services to excluded people. There is no need for much theory about social performance. Does the MFI contribute to answering a need? Is the portfolio at risk correct? Are clients satisfied and paying back their loans and staying with the MFI? Then it is OK! The most important is client satisfaction, no need to measure poverty levels


This lack of a common view of what social performance entails is also a major impediment at the scale of the sector, because it brings confusion to MFIs with regards to the social standards they should respond to. On the other hand, risk and uncertainty aversion dont play a major role: all respondents explained that risks in microfinance are high but usually well understood and diversified in portfolios, in particular through country diversification. From the fund managers point of view, risk aversion and short-termism are not applicable in microfinance and are not an impediment as such to the integration of social criteria in investment processes.

3.2.2. Organizational impediments The most important question regarding organizational impediments is how social performance criteria are integrated to the core investment decision process. We asked respondents to explain what the first screening criteria for potential investments are, and for most MIVs they are exclusively financial. As for the role of social performance into the final investment decision, no one has given a clear weight for social criteria. You know, there is no exact formula. It depends on the track record of MFI, if we know them. For example if their financial base is sound but there is no social performance, its a no go. It is case by case, it depends on market conditions. There is no weighting between financial and social performance, but social aspects are heavier than financial I cant give you a weigh for social performance, but as long as the MFI has good intentions and is aware of the importance of social performance, its OK. There is no weighting because there is no score at all for social performance. But social aspects are taken into account in a qualitative approach. The tendency is that the main decision is based on financial risk, and if social performance is good then the investment is very good. However, this absence of a clear and formal integration of social aspects in the investment approach is an important impediment that needs to be tackled if MIVs want to demonstrate their social commitment to investors.


Regarding organization dominant values, respondent were asked about their perception of the relationship between financial and social performance. There was also a broad consensus on this issue: the relationship is perceived negative for small MFIs (because social performance management is costly) and then positive for well-established MFIs, which have more resources to dedicate to costly policies such as client satisfaction surveys or training programmes for staff. Talking only for debt investments, there is a positive correlation. If we maximize social performance, it lowers the credit risk. For example in Nicaragua, more social MFI are doing better than the others. No, the relationship is positive because staff is motivated if well treated, and customers come back if the service is good. But all this necessitates a certain level of sustainability; it depends on the profitability level of the MFI. There is only a trade-off for small MFIs: big ones will have more resources to deploy for social performance. Yes, there is a trade-off for instance in rural areas where sometimes you have no physical infrastructure. But, it is less strong if we work with the less poor. In the same vein, when asked about the meaning of being double bottom line for an MIV, fund managers demonstrated that the objective of simultaneous social and financial returns is rather a belief than an actual practice. They dont have any formal policy regarding the right mix between financial and social objectives; they just believe that social and financial performances are positively correlated for profitable MFIs. Regarding the social performance indicators used by MIVs, most of them still integrate output indicators in their reporting to investors: total borrowers, gender, average loan size Although all interviewees are aware that these indicators dont reflect real social performance, they recognize that at the same time they are very easy to aggregate for reporting to investors, who are fully satisfied with it. While in SRI, the screening role is played by CSR rating agencies, the use of social ratings remains limited in microfinance, and most MIVs use in-house assessment tools to evaluate an MFI. Social audits (such as the CERISEs SPI) are perceived as important for MFIs to position themselves towards their stakeholders, but not very good for an assessment because of the biases involved if done internally by the MFIs. MIVs also stress the importance of 16

ratings because they are made by an external body. However, respondents feel the need to complement the ratings (when available and not outdated) by their own due diligence process. Finally, regarding fund managers performance review and incentives, very few mention social aspects in their performance assessment, but they also mention very few incentives related to volume of profit objectives. Many respondents have a fixed salary and team incentives.

3.2.3. Institutional impediments With respect to the institutional environment of MIVs, a very important element is the absence of a microfinance-specific regulation in Luxembourg and Switzerland (the two main countries where MIVs are incorporated). No obligation at all for funds to report on social performance to their investors makes a major impediment to its integration in investment decisions. In European and US SRI, regulation has been a major driver of industry development by setting mandatory disclosure requirements (Renneboog et al., 2008). As a result, reporting to investors and investments follow-up in microfinance are mostly based on output indicators (average loan, women percentage, total borrowers), but on the other hand, investors are said by fund managers to be satisfied and not asking for more information on social performance. Regarding fiduciary duty and duties of prudence, most respondents explained that investors are risk averse, but profit requirements remain quite limited, with no minimum return expected or at least not a higher return than industry benchmarks. Another element relates to the professional skills in the MIV industry. Some explained that most fund managers have a mainstream investment banking background, and not enough expertise in social aspects. Many respondents also explained that the industry would benefit having a better risk management, especially after the over-indebtedness crisis that happened recently in India. Taken together, this lack of expertise in social aspects and the respondents big concern about risk management skills make a considerable impediment to the integration of social performance as a main decision criterion. Finally, all respondents acknowledged the current herd behavior happening in the sector, with most MIVs focusing on the same small number of mature and profitable MFIs. This is a


strong selection bias and a major impediment to really consider social performance when making investment decisions.

5. Discussion and conclusion The microfinance investment vehicles industry is today at a bottleneck. In a context of a damaged reputation of microfinance, the whole field of microfinance and especially the investment vehicles, funded by public money and by socially inclined investors, have to demonstrate and justify their commitment to social returns. The main objective of this paper was to identify what the MIV industry can learn from the experience of the broader SRI sector, in terms of integrating social performance into their core investment processes. Indeed, the SRI sector has a longer track record than MIVs and has demonstrated a positive impact on industry behavior regarding investees corporate social responsibility. However, the lack of standardization in the methodologies of CSR rating agencies is a problem that leads to confusion for firms regarding the standards to which they should respond. In addition, many impediments are limiting fund managers to have a true SRI behavior when investing, and can be analyzed at three levels: individual, organizational and institutional. We used a qualitative methodology to identify the main impediments to the integration of social performance as a decision criterion in microfinance, using the Juravle and Lewis (2008) framework in three levels. The overall finding is that while social performance is recognized by respondents to be an important topic for the industry, fund managers still dont give a strong role to social criteria in investment decisions. We argue that this is linked to a number of major impediments such as the tendency to believe that microfinance is social per se, the lack of standardization in social tools and also a loose regulation regarding social reporting. The belief of fund managers that microfinance is social per se has to be nuanced by their perception of the relationship between financial and social performance of MFIs. Indeed, as long as they continue to think that there is a trade-off for small MFIs regarding social performance, they will tend to continue focusing on big MFIs according to their financial performance. However, the SRI literature has largely documented a positive relationship for all types of companies, meaning that caring about social aspects always pays back (in the long


run) in terms of financial performance. We think that MIVs still have to make that observation in microfinance to be able to change their behavior. The lack of standardization in social tools is an important issue that the broader SRI sector also faces. Nevertheless, the literature shows an overall positive impact of SRI on corporate CSR practices, even if the methodologies of CSR rating agencies are questioned. The MIV industry relies very little on external bodies to make the assessment of their potential investments, because they dont trust self-reported MFI social performance, and because microfinance ratings still dont aggregate financial and social performance in one single assessment at the moment. If the microfinance rating agencies can manage to harmonize their methodologies and social indicators used, they could play a greater role in the future of microfinance. The loose regulation is also a major impediment. Indeed, there is no obligation in terms of social reporting in microfinance, when it has been a major driver of European and US SRI development, thanks to the setting of mandatory CSR disclosure requirements for SRI funds (Renneboog et al., 2008). As a conclusion, the impediments that have been identified in this study should help industry practitioners and scholars think of a way to make microfinance investments change from a negative screening approach (which seems to be currently the case: aiming at a good financial performance under a social constraint ) to a true positive approach, with social performance criteria at the heart of the screening process because after all, what socially responsible investments need in the first place, is to actually be socially responsible


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Appendices 1. Juravle and Lewis (2008): Analysis framework of the impediments to SRI

Source: Juravle and Lewis (2008, p.303)


2. List of respondent MIVs and peer group origin Advans SA, Sicar Alterfin cvba/scrl ASN-Novib Fund Dexia Micro-Credit Fund, SICAV II Dual Return Sicav II Vision Microfinance sub-fund Dual Return Sicav II Vision Microfinance local currency sub-fund Impulse Microfinance Investment Fund Incofin cvso Luxembourg Microfinance Development Fund Sicav NOTS Microfinance Fund Oxfam Novib Fund ResponsAbility Global Microfinance Fund ResponsAbility Mikrofinanz-Fonds ResponsAbility Microfinance Leaders Fund Rural Impulse Fund I SICAV-FIS Rural Impulse Fund II SICAV-FIS Triodos Sicav II Triodos Microfinance Fund VDK spaarbank Volksvermogen

Repartition in CGAP peer groups ( Public Placement Funds Private Placement Funds Cooperative companies/NGOs Holding Companies 8 8 2 1


3. Representativity of the sample